Get help from the best in academic writing.

The Importance of Working Capital Management

Working capital management defines the management in the short term of the relationship between a company’s current assets and liabilities. The most common elements of working capital will include inventory, receivables and payables which represent the operating working capital (OWC) held by a company usually within a year. Fig.1 below shows the interaction between these elements of OWC.
The goal of OWC management is to ensure that a company has enough cash flow, measure in terms of liquidity, to satisfy its short term debts and continue to support its day to day operations. Most articles and books discuss the significance of OWC in terms of obtaining an optimal balance between inventory, receivables and payables, McLaney E. and Atrill P., Accounting: An Introduction (Prentice Hall, 2008). Abraham et al., Accounting for Managers, (Cengage, 2008) further expatiates on this critical importance and state that most organisations invest between 25 – 40% of their net assets on OWC which represents a major short term investment. However, these books present a generic methodology to OWC and do not consider a firm’s unique nature, industries or size. Furthermore, this significance of working capital will depend on its size and composition and will vary between industries such as Rolls Royce Plc a manufacturing company will place particular attention to its high inventory levels and payables unlike British Airways Plc a service provider with no inventory. Thomas M. Krueger, An Analysis of Working Capital Management Results Across Industries, American Journal of Business, 2005, vol 20 presented a research based on the annual ratings of working capital management across industries published in CFO magazine. The result indicated that there was a consistency in working capital measures within industries but the working capital measures were are not static over time. In an online article Philip McCoster (2003), Accountancy: The Importance of Working Capital, (http://www.accountancy.com.pk/articles_students.asp?id=77).[Online].(Accessed 28/03/11) agrees with this dynamic nature of working capital and highlights this importance in more subtle way that most organisations are profitable on paper but are forced to cease trading because they cannot meet short term debts. According to him, small businesses in particular are prone to fail especially during start up because they ignore the importance of working capital problems.
Generally the importance of working capital is indisputable and whether its elements are managed as a whole or individual, its management is still important in order for an organisation to effectively manage its cash flow to continue operation. But while this is most said in papers, it seems rather paradixocal that in reality the importance OWC is ignore and most companies find themselves at the point of bankruptcy as was the case in the winning margin game.
As a production manager in the ‘Winning Margin game’, I realised that the decisions I made especially in forecasting and managing machines output was very critical to the overall amount of finished goods inventory needed to achieve a positive OWC. This was clearly depicted in year two when two critical decisions;
Forecasted a total production output of 11 costing $40 (appendix: Production and Sales Plans For The Year Ahead).
Purchase of two additional Mark II machines (See appendix: Balance Sheet)
This resulted to an increase in the amount of inventory to contracted amount although some inventory was tied up in Work in Progress and Finished goods leading to a drop in operating working capital (Year 2 Cash Flow Statement). Furthermore, the cash spent on new machines also led to a drop in the operating cash flow of the business. Therefore, in real life the production manager role is strategic and has a big impact on working capital and the overall business objective but his/her decisions can only be as effective when taken in collaboration with other departmental heads.
2.2 BUDGETING McLaney E and Atrill P., Accounting: An Introduction (Prentice Hall, 2008) defined a budget as a short term financial plan prepared by a business as an integral part of its strategic plan framework. A budget is use by managers to examine and compare between the actual to what was planned in a process known as the budget control. By using this technique, Group E benefited from the budgetary process in many ways:
Forward thinking and identification of short-term problems: During the planning process of year 2, we realised that we had to budget for additional machine as well as additional loans. Doing this in good time gave us time to consider alternatives and chose the best course of action to take.
Improved co-ordination: Doing planning each year meant we had to co-ordinate with each other. This was crucially beneficial because it improved visibility and decisions making as all activities were linked together. For example, decisions on production depended on sales estimates, raw material availability and funding to finance it.
It provided a system of Control: At the beginning of each year, we had to compare year 1 and 2 performance and established areas of concerned. This provided a system of control and better planning for year 3.
It created a system of authorisation: By deciding on a master plan of action for each year, this helped set expenditure limits especially as I, the production manager, wanted to increase amount of machine purchased in year 2 but was restricted.
The budget motivated us to perform better: By establishing responsibilities to each member of the group, was beneficial to the whole team as each member’s felt they had contributed to the overall business objectives. Hence improving the team’s spirit to perform.
2.3 Absorption Costing Absorption costing is a method of calculating the full output cost by charging direct costs with a fair share of indirect costs. The essence of absorption costing is to make costing simpler and easier so that management can make informed decisions. In the ‘Winning Margin’ game, the use of this technique was beneficial to our group in several ways:
Helpful in making output decisions: Absorption costing technique made calculating planned sales easier and as a team we were able to make informed decisions on production and cash flow.
Exercising control decision: absorption costing is often used as a basis of budgeting and budget control. Therefore, it was beneficial to the team as it formed the basis of our budget and we were able to exercise control over our budget and plans
Furthermore, the technique was particular useful to achieve efficiency since we were able to make decisions that compares alternative costs of doing similar things. For example we compared the costs of buying a Marked II or Mark III machine in year 2 as well as deciding between the various types of product to produce.
In addition to this, absorption costing technique was significant as we were able to assess our team’s performance. Its use made calculating yearly production cost, sales, profit and other financial data easier. This made facilitated the process of assessing our business and team performance for any given year.
Although widely practiced, in real life the use of absorption costing technique will not be as simplistic as in the game. Moreover, the technique has been criticised for its use of past costs which are considered irrelevant in the decision making process as decisions need to reflect the future not the past. Other costing techniques such as variable costing are recommended. (Words 300)

Mmcl Would Require Us To Bear The Closure And Reclamation Costs Accounting Essay

Executive Summary The strategic location of the South Face Mine, owned by Mountain Mining Canada Ltd (MMCL), catches the attention of Can-Do to make an offer for purchasing the mine. If our company successfully acquires it, the combination of better surface logistics and optimal location of new drift mines could provide an annual cost saving of up to $1.5 million for 20 years. However, MMCL has closed the mine and currently been spending on closure and reclamation of it; undoubtedly MMCL would like to transfer those costs to us.
The purpose of this memorandum is to determine the walk-away point, which is the highest amount Can-Do would agree to offer in the negotiation with MMCL, with the use of data from the management budget provided by MMCL, the discounted cash flow model and sensitivity tests on various assumptions.
Given the data in the MMCL management budget with removal of costs which are not transferred to Can-Do or can be internalized [1] , and assuming a 6% interest rate for discounting, the 15% contingency allowance used in MMCL implies an inflation rate of 2.55%.
Having studied various assumptions, the sensitivity tests indicate the variance of short-term duration is the most important risk underlying as a 1-year extension of short-term costs reduces the value of acquisition by $6.6 million from $15.5 million to $8.9 million (58% of original value). A 2-year extension further reduces the value by 6.4 million to $2.5 million (16% of original value). [2]
The recommended walk-away point would be $14 million, a value lower than the net values of acquisition calculated in most sensitivity tests excluding those with respect to short-term duration and estimated cost saving. It also means that an efficient cost control should be performed to avoid an extension of short-term cost and a failure to realize the estimated cost saving.
It is also worth noting that there are large discrepancies of cost items between the 2006 and 2005 budgets. A detailed review on financial data is suggested so as to find out any hidden problems or risks.
Introduction The purchase of the South Face Mine, currently owned by Mountain Mining Canada Limited (MMCL), can provide Can-Do a very large reduction in operating cost of North Fork Mine, located adjacent to South Face Mine, by an estimated amount up to $1.5 million annually for the next 20 years, attributed to the optimal location of new drift mines and the improved logistics.
However, it is expected that MMCL would require us to bear the closure and reclamation costs. Therefore, the net value of the acquisition is the value of cost saving net of the value of those additional costs.
By considering the data provided and computing the net value of acquisition, it comes up with the walk-away point, which is critical and crucial to our negotiation with MMCL. The remaining parts of this memorandum explain the determination of the walk-away point. In particular, the purpose of this study is to:
Review the financial data provided
Do sensitivity tests for assumptions with respect to the closure and reclamation costs
Set a reasonable walk-away point
Identify other possible risks for the determination of the walk-away point
Data Source of Data MMCL has provided the 2005 and 2006 management budgets for the closure and reclamation costs of South Face Mine. The following table summarizes the cost projected from 2006 onwards:
Item 06 Budget ($’000) 05 Budget ($’000) Diff. ($’000) Diff. (in %) Direct Cost 6.0) Water Treatment
3,391
1,583
1,807
114.15%
9.0) Tailing Storage Facility Reclamation
575
345
230
66.67%
11.0) Facilities Demolition
2,821
2,303
517
22.47%
12.0) Facilities/Equipment Disposition and/or Salvage
218
347
(129)
-37.27%
13.0) Inventory Disposition
(5,270)
(5,511)
240
-4.36%
14.0) Post Closure Monitoring Costs
1,319
320
999
312.03%
Total Direct Cost 3,052 (613) 3,664 -598.21% Indirect Cost 15.0) Socio-Economic Costs
19,500
15,500
4,000
25.81%
16.0) Consultant Services
388
225
163
72.22%
18.0) Owners Management (post closure)
4,075
1,600
2,475
154.69%
22.0) Bonding Cost
270
90
180
200.00%
23.0) Contracts/Commitments/Royalties
1,250
705
545
77.30%
24.0) Taxes (Land, Buildings etc…)
2,700
4,800
(2,100)
-43.75%
30.0) Contingency*
1,760
1,021
739
72.40%
Total Indirect Cost 29,943 23,941 6,002 25.07% Total Cost 32,994 23,329 9,666 41.43% * Note: The value items above do not reflect any time value; instead the indirect cost “Contingency” implicitly bears it.
Table 1: Management Budget of Closure/Reclamation Plan Cost from 2006 onwards There are different types of costs, including short-term costs which will be incurred within five years and long-term costs which will be incurred during the whole reclamation period. There are also salvage values of equipments remaining on site (i.e. Inventory Disposition), and they will accrue to Can-Do. Moreover, MMCL has included a 15% contingency allowance in its calculation.
From the table above, it is clearly observed that large discrepancies exist for most cost items between 2006 and 2005 budget, and this indicates a deficiency of the contingency allowance in 2005 to cover the adverse development of costs estimated from 2005 to 2006. It concerns us about the accuracy and reliability of the predictions. It is suggested a detailed review of financial data as well as other information related to the situation of the mine be conducted in order to discover any potential problems which may put our company at risk.
Data Adjustment The data provided is subject to adjustments so as to calculate a more reasonable walk-away point. They include:
Removing costs not to be transferred from MMCL to Can-Do (e.g. severance costs)
Removing costs which could be realized from internalizing them in Can-Do (e.g. inspection costs)
The details of data adjustments are mentioned in the Appendix, and the following table shows the modified budget for South Face Mine from 2006 onwards:
Item Modified 06 Budget ($’000) Direct Cost 6.0) Water Treatment
3,391
9.0) Tailing Storage Facility Reclamation
508
11.0) Facilities Demolition
2,821
12.0) Facilities/Equipment Disposition and/or Salvage
218
13.0) Inventory Disposition
(5,270)
14.0) Post Closure Monitoring Costs
1,319
Total Direct Cost 2,985 Indirect Cost 15.0) Socio-Economic Costs
– 16.0) Consultant Services
388
18.0) Owners Management (post closure)
2,375
22.0) Bonding Cost
270
23.0) Contracts/Commitments/Royalties
– 24.0) Taxes (Land, Buildings etc…)
2,700
30.0) Contingency*
1,307
Total Indirect Cost 7,040 Total Cost 10,024 Table 2: Modified and Original Budget from 2006 onwards Analysis: Methods

[casanovaaggrev]